15
chapter External regulation of
business
Needs of
stakeholders
Regulation
Legislation
Other methods
251
External regulation of business
1
The needs and impact of stakeholders
Stakeholder Needs
Shareholders Profits, to h
share price.
Employees
Suppliers
Customers
Local
community
•
252
Issues
Directors may
be serving own
needs.
Directors may
be paying
themselves too
much. Poor
decisions could
risk corporate
failure.
Solutions
Corporate
governance rules
and legislation.
Job security,
Corporate
fair wage,
governance rules
safe working
and disclosures,
conditions, fair
Health and
employment
Safety legislation,
practices.
etc. Sex/Race
Discrimination
legislation.
Prompt payment. Company may be Access to
insolvent.
audited financial
statements,
insolvent trading
legislation.
Continued
Company may
Financial
supply, ethically- become insolvent. statements, social/
produced goods.
environmental
legislation and
disclosure.
Jobs, safety
Emphasis on
Employment
(transport,
profits could lead protection
emissions, etc.) to other needs
legislation,
being ignored.
environmental
protection, etc.
Corporate governance, etc. covered elsewhere. This section
concentrates on regulation by legislation.
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chapter 15
Illustration 1 – The needs and impact of stakeholders
Tasty Biscuits Limited produces biscuits in its factory in Liverpool.
List four safety issues that could affect stakeholders and the areas
of legislation/regulation that would regulate them.
Issue
Area of regulation
Delivery lorries may be unsafe,
e.g. faulty brakes.
Road transport, e.g. MOT, safety
inspections.
Butter and other ingredients
may be stored at incorrect
temperatures.
Food safety regulations.
Factory machinery may be
unsafe, e.g. no guard rails on
cutting machines.
Factories Act etc., Health and
Safety legislation.
Temperature in factory may be
too high/low.
Health and Safety.
Test your understanding 1
Classy Coffee Limited imports and distributes organic coffee.
List 5 specific stakeholders and the areas with which they
would be concerned.
Stakeholder
Area of concern
1
2
3
4
5
2
Effects of regulation upon business
2.1 Addressing market failure
Regulation appropriate where:
•
imperfect competition, e.g. monopoly
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External regulation of business
•
externalities, e.g. reducing pollution, banning smoking
•
imperfect information, e.g. improving quality standards
•
equity, to improve social justice, e.g. sex discrimination legislation.
2.2 Protecting public interests
•
To ensure that needs of stakeholders other than shareholders
are met (see above).
Regulation may:
•
increase or reduce the social standing of various social groups
•
promote the collective desires of a significant section of society
•
enhance opportunities for the formation of diverse preferences and
beliefs in society
•
affect the development of particular preferences across society as
a whole
•
deal with the problem of irreversibility (current activities will result
in outcomes from which future generations may not recover) e.g.
global warming.
2.3 Examples of regulation/regulatory bodies
2.3.1European Union (EU)
•
EU regulations – obligatory in all member states, overrule UK law.
•
EU directives – must be incorporated into national law to become
effective.
2.3.2 Environment Protection Agency (EPA)
•
Oversees environmental regulation.
2.3.3Competition regulators
254
•
Office of Fair Trading (OFT) – investigates those suspected of
breaching Competition Act (e.g. price fixing, cartels, abusing a
dominant position).
•
Competition Commission – independent body which conducts
enquiries into mergers, takeovers, etc.
•
Takeover Panel – Part of Competition Commission. Enforces City
Code on Takeovers and Mergers for listed companies.
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Illustration 2 – Effects of regulation upon business
A, B and C are three companies in the oil industry.
A complaint has been made to the OFT that these three companies
have been operating a cartel and colluding on prices.
List the impacts on the businesses.
•
OFT officials can enter premises and demand relevant
documents to establish whether prices have been fixed.
•
If proven, the fine can be up to 10% of annual worldwide
revenue.
•
Third parties may be able to claim for damages from the
business if it has been found to breach any of the prohibitions.
•
There will be adverse publicity.
•
Competition Disqualification Orders may be made against the
directors.
•
The share price may be adversely affected.
Test your understanding 2
Give three examples of matters that might be deemed anticompetitive.
1
2
3
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External regulation of business
3
Key international legislation
3.1 Why the need for international regulation?
Globalisation g companies operating in many different countries g
requirement for international regulation.
Advantages of international trade:
•
Efficient allocation of resources – countries specialise in what
they’re good at.
•
Can transfer raw materials from those with surplus to those with
deficit.
•
Increased competition from new competitors g increased
efficiency.
•
Larger markets g economies of scale.
•
Trading links g closer political links.
3.2 Regulations to encourage free trade
3.2.1Barriers to international trade:
•
Tariffs or customs duties.
•
Import quotas/embargoes.
•
Hidden subsidies/import restrictions.
3.2.2Free trade bodies
•
World Trade Organisation (WTO) – set up in 1995 to promote
free trade, remove barriers.
•
EU – intended to operate a single European market, to allow free
movement of labour, goods and services, and free competition.
•
Other regional trading organisations, such as NAFTA (USA,
Canada, Mexico) and ASEAN (South East Asia).
3.3 Sarbanes-Oxley Act 2002 (Sarbox)
3.3.1Background
Enron, WorldCom, other corporate scandals g concern about
corporate responsibility, internal controls, financial reporting, role of
auditor.
3.3.2International implications
Overseas companies who are part of group listed on IS stock exchange
must comply.
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3.3.3Main provisions
Auditor independence
Auditors are restricted in
the additional services
they can provide to an
audit client.
US stock
exchange
regulations
Required under
the Act – very
similar to UK regulations.
Audit committee
Company must have an
audit committee – will be
disallowed from trading if
does not have one.
Sarbanes-Oxley
Act Key points
Internal control
report
Annual report must
include statements
concerning the
internal control
systems in the
company.
Increased financial
disclosures
Financial reports to detail
off-balance sheet financing.
Measures introduced by the Act include:
•
All companies with a listing for their shares in the US must provide
a signed certificate to the Securities and Exchange Commission
vouching for the accuracy of their financial statements.
•
If a company’s financial statements are re-stated due to material
non-compliance with accounting rules and standards, the chief
executive officer and chief finance officer must give up bonuses
awarded in the previous 12 months.
•
Restrictions have been placed on the type of non-audit work that
can be performed for a company by its firm of auditors.
•
The senior audit partner working on a client’s audit must be
changed at least every five years (i.e. audit partner rotation is
compulsory).
•
An independent five-man board called the Public Company
Oversight Board has been established, with responsibilities for
enforcing professional standards in accounting and auditing.
•
Regulations on the disclosure of off-balance sheet transactions
have been tightened up.
•
Directors are prohibited from dealing in the shares of their
company at ‘sensitive times’.
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External regulation of business
Key effects of the Sarbox legislation are:
•
Enforcement: - Sarbox takes a robust legislative approach which
sets out clear personal responsibility for some company directors
with a series of criminal offences that are punishable by fines (both
company and its officers) or lengthy jail sentences.
•
Documentation: – Sarbox creates a much more rigorous demand
for evidencing internal controls and having them audited.
Illustration 3 – Key international legislation
You are advising the director of XYZ Limited, a 100% subsidiary of
XYZ Inc, which is listed on the New York Stock Exchange.
Explain the impact of Sarbox on XYZ Limited.
As XYZ Limited is the subsidiary of a listed group the Sarbox Rules
apply.
XYZ Limited should have a comprehensive external audit by a
Sarbox-compliance specialist to identify areas of risk.
Specialised software should be installed to provide electronic paper
trails necessary to ensure Sarbox compliance.
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Test your understanding 3
Decide whether the following Sarbox provisions are
true or false.
Provision
True/False
Auditors of a company are restricted in the type of
non-audit work they can do for them.
Senior audit partner working on a client’s audit must
be changed every 5 years.
All main board directors must have a university
degree.
Directors are prohibited from dealing in their
company’s shares at ‘sensitive times’.
A company must change its auditors every 6 years.
Bonuses must not be paid to the chief executive
and chief financial officer until 12 months after the
company’s year end.
Bonuses to the chief executive officer and chief
financial officer awarded in the previous 12 months
must be given back if a company’s financial
statements are re-stated due to material noncompliance with accounting rules and standards.
All companies with a listing for their shares in
the US must provide a signed certificate to the
Securities and Exchange Commission vouching for
the accuracy of their financial statements.
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External regulation of business
Chapter summary
Needs of stakeholders:
Shareholders
Customers
Suppliers
Employees
Local community.
Regulation:
Reasons for regulation
Regulatory bodies.
Legislation:
International regulatory bodies
Sarbanes-Oxley.
260
Other methods:
Covered in other
sections.
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chapter 15
Test your understanding answers
Test your understanding 1
Stakeholder
Area of concern
1
Customers
Ensuring that coffee is genuinely organic
and not contaminated.
2
Suppliers
Ensuring that a fair price is paid.
3
Employees
Ensuring that a fair wage is paid.
4
Shareholders
Ensuring that the company makes a high
profit while considering the needs of the
environment, etc.
5
Local community
Ensuring that deliveries, etc take place
with minimum disruption.
Test your understanding 2
1
Two accounting firms merge, and the merged firm has a market
share of 50%. This would be deemed to be a dominant position,
and the merger may be banned in order to prevent abuse.
2
Two construction companies (A and B) are each bidding for the
same two contracts (X and Y). They agree that A will bid high
on contract Y and B will bid high on contract X so that both will
be successful on one bid (A on X and B on Y).
3
Two supermarkets agree to fix the price of certain goods at an
agreed level and to avoid competing on price.
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External regulation of business
Test your understanding 3
Provision
True/False
Auditors of a company are restricted in the type of
non-audit work they can do for them.
True
Senior audit partner working on a client’s audit must True
be changed every 5 years.
262
All main board directors must have a university
degree.
False
Directors are prohibited from dealing in their
company’s shares at ‘sensitive times’.
True
A company must change its auditors every 6 years.
False
Bonuses must not be paid to the chief executive
and chief financial officer until 12 months after the
company’s year end.
False
Bonuses to the chief executive officer and chief
financial officer awarded in the previous 12 months
must be given back if a company’s financial
statements are re-stated due to material noncompliance with accounting rules and standards.
True
All companies with a listing for their shares in
the US must provide a signed certificate to the
Securities and Exchange Commission vouching for
the accuracy of their financial statements.
True
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